The Informal Economy Debate: Four Dominant Schools of Thought

Dualist School:
ILO World Employment Mission Kenya 1972

  • characterization of informal activities:
    • autonomous activities with few (if any) links with the rest of the economy
    • 7 widely-cited features:
      • ease of entry
      • reliance on indigenous resources
      • family ownership of enterprises
      • small scale of operations
      • labour-intensive and adapted technology
      • skills acquired outside the formal school system
      • unregulated and competitive markets
  • causal theory: exclusion from modern economic opportunities due to two imbalances – between:
    • growth of population + growth of modern industrial employment
    • people’s skills + structure of modern economic opportunities

Structuralist School:
Manuel Castells and Alejandro Portes 1989

  • focus: relationships of production
  • characterization of informal economy = specific form of relationships of production + unregulated by the institutions of society
    • universal
    • heterogeneous
    • on the rise
    • systemically linked to capitalist/formal firms
  • composition of informal economy = self-employed + wage employed
    • petty artisans
    • petty traders
    • sub-contracted workers
    • casual laborers
    • informalized (i.e., once formal) wage workers
  • causal theory: informality due to nature of capitalism/capitalist growth -
    • attempts by formal firms to
      • reduce labor costs
      • increase competitiveness
    • reaction of formal firms to:
      • power of organized labor
      • state regulation of the economy, notably taxes + social legislation
      • global competition
    • process of industrialization: notably, off-shore industries + sub-contracting chains + flexible specialization

Legalist School:
Hernando De Soto 1989

  • focus: rural-to-urban migrants in Lima, Peru
  • causal theory: hostile reception, especially from the legal system, leads to
    • informal activities
    • extralegal norms
  • costs of formalization:
    • costs of becoming formal: registration + license
    • costs of remaining formal: taxes + compliance with regulations/laws + higher rates for public utilities
  • costs of informality:
    • costs of illegality:  to economy of…
      • avoidance of fees and penalties
      • avoidance of taxes and labour laws
    • costs of absence of good law: to informal workers
      • not having property rights
      • not having enforceable contracts
      • not receiving benefits from formal sector

Voluntarist School:
William Maloney 2004

  • focus: self-employed, notably micro-entrepreneurs + especially male micro-entrepreneurs
  • causal theory:  informal sector is “voluntary”: i.e., micro-entrepreneurs choose to operate informally – after weighing costs-benefits of formality vs. informality
  • costs of formality: payroll taxes and social protection contributions
  • benefits of informality: way to earn income while avoiding costs of formality